Up 21% so far: Mid and smallcap indices thrive in H1 2024, but valuation concerns loom for H2

Mid and small-cap stocks in India have shown strong performance, but high valuations make them volatile. Experts advise a cautious approach and suggest focusing on quality stocks for potential alpha returns. Selectivity and bottom-up investment approach are recommended for long-term wealth creation.

Small and Mid-caps have remained market favorites so far this calendar year. Stocks from this space have witnessed exceptionally strong demand by retail investors in the first half of 2024. Year-to-date, the Nifty Midcap and Nifty Smallcap indices have both surged approximately 21 percent, outperforming the benchmark Nifty's 10.5 percent rise. Specifically, the Nifty Midcap index has outperformed the Nifty in four of the six months this year, while the Nifty Smallcap index has delivered higher returns in three of those six months. Meanwhile, Over the past year, the Nifty Midcap and Nifty Smallcap indices have soared by 51 percent and 60 percent, respectively, compared to the Nifty's 26.5 percent increase. This strong performance is attributed to solid economic fundamentals, increased retail investor participation, and robust corporate earnings growth. Economic expansion has created a favorable environment, while the surge in demat accounts and continuous inflows from mutual funds and SIPs have boosted demand for these stocks. Additionally, sectors such as real estate and defense, heavily represented by mid and small-cap companies, have shown strong earnings growth, further bolstering these segments. However, experts caution that valuations in the mid and small-cap segments are now stretched, which may lead to a more moderated performance in the second half of 2024. They advise investors to be selective and stick to a bottom-up investment approach. Let's take a look at what they have to say: Tanvi Kanchan, Head - UAE Business & Strategy, Anand Rathi Shares and Stock Brokers Despite their strong performance, mid and small-cap stocks in India face significant concerns due to high valuations and this high valuation makes these segments prone to volatility. While mid and small caps have shown strong performance in India, the high valuations and potential for volatility necessitate a cautious approach. Quality stocks in mid and small-cap still have the potential to deliver 5-6 percent alpha over and above the large-cap index, so the investors who are looking at higher risk and higher returns, even with a 3x-4x overvalued in comparison to large-cap, the segment can be explored. Apurva Sheth, Head of Market Perspectives and Research, SAMCO Securities Small and Mid-caps have remained the darling of the market so far. Stocks from this sector have been sought after by retail investors. The domestic money fund flow is testimony to this as the majority of domestic funds go to this category in the Mutual Fund industry. However, going ahead, whether the outperformance in this category continues or fizzles out, will depend on two major events slated for next month in July. The first is the Union budget and corporate performance of these companies in the first quarter of FY’25. If there are any interesting Budgetary provisions announced coupled with consistent Q1 performance, the small and mid-cap companies will continue to attract investor attention. If they fail to perform and don’t meet the market expectations, the setback in the momentum cannot be ruled out. Ravi Singh- SVP, Retail Research, Religare Broking Ltd. On a larger picture, we are positive on the small and midcap space but in the short term we may see outperformance from the large caps and one should not be aggressive on the mid and small-cap space so one can book some profits as well. Anirudh Garg, Partner and Fund Manager at Invasset From a long-term perspective, we believe mid and small-caps hold strong potential due to India's economic expansion and the ongoing capital expenditure (CapEx) programs. The government's focus on infrastructure projects and industrial growth supports the growth narrative for these stocks. As India progresses towards a higher GDP trajectory, the value and growth opportunities in mid and small-cap stocks are likely to become more pronounced. While short-term volatility is expected, investors should be prepared for such dips and maintain a long-term investment horizon. The potential for growth remains significant, driven by India's rising prominence in the global supply chain and domestic consumption growth. Therefore, selectively investing in fundamentally strong mid and small-cap stocks can be beneficial. Mohit Khanna, Fund Manager at Purnartha One Strategies YTD Nifty 50 TRI has delivered 11 percent returns as compared to 22 percent for Nifty Midcap 150 TRI and 21 percent for Smallcap 250 TRI. This run-up has increased the valuation gap between the large caps and mid & small caps. In this regard, there can be some near-term underperformance by the Mid/Small-cap Indices. Having said that, there are still a lot of stocks in the Mid/Small cap arena that have underperformed and are available at reasonable valuations. I would suggest investors to be selective and stick to a bottom-up investment approach, rather than top-down/index-level return calculations. Focus on earnings growth and valuations at an individual stock level is a better way of building a winning portfolio, in my opinion. Trivesh D, COO at Tradejini The valuations of mid and small-cap companies continue to be in the expensive and extremely bullish category. On account of smaller m-caps, these companies are susceptible to significant volatility which may induce investors to participate in such companies without a clear understanding of the operations and future growth prospects of these companies. I advise investors to maintain discipline in stock selection and the decision should not be merely based on speculation and FOMO to ensure long-term wealth is built. Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.